The economy and what it means for the defense industry

Posted by John Keller

President Obama's speech Thursday night, it looks to me, means not much is going to change. What worries me is the president apparently believes that government directly is capable of creating jobs. Now I know all presidents talk about government's creating jobs, but I don't think any president really believed it -- until now.

The private sector is not going to shift out of neutral, and will not get on with the business of job and wealth creation, until business leaders have some sense of the tax rates they will face in the long term, as well as the burdens from government they must bear, such as minimum wages, health insurance costs, and other factors. This holds true for the defense industry, as well as for other private business.

We have an offer from Obama of only temporary tax reductions, and a looming federal health care plan that could begin placing unprecedented costs on businesses and individuals starting in 2014. In sum, no one in private business is sure what they'll face over the next few years, and as long as that uncertainty remains, don't expect private business to do much hiring or investing -- even in the defense industry.

On a simplistic level, this might not make much sense. After all, doesn't the defense industry's fortunes rise and fall exclusively on levels of federal spending? While this may be true to a great extent, the defense industry also relies on a healthy private-sector economy, which today we don't have.

Think of the many layers of the defense industry supply chain. What percentage of suppliers to the U.S. military do you think receive checks directly from the government? I'll wager it's less than half -- and perhaps far less still. Everyone else is making money from the primes and subcontractors. If those primes and subcontractors are worried about the economy, they won't spend for internal research and development, and won't be in the mood to take the kinds of risks necessary for technological innovation.

Instead, they'll spend only as much money on goods and services as they have to, and nothing more. This kind of stagnation will remain, as long as the defense industry, like everyone else, is paralyzed with uncertainty.

Now couple that with the dread building in the defense industry over prospects of deep cuts in the Pentagon's budget. There's worry about business prospects in general, and about cuts in the defense budget in particular.

These aspects don't add up to a very pretty picture.